Opinion | Will lower Chinese savings tighten global liquidity?

Rajesh Kumar

There is one big change happening in the global economy. China is expected to run a current account deficit this year for the first time since 1993.

One of the biggest suppliers of savings to the global economy would now, with rising consumption, start importing capital. Although accommodative financial conditions, thanks to the u-turns made by the US Federal Reserve and the European Central Bank would help smoothen the transition, the change will still have implications for both China and the global economy.

First, the lack of surplus savings in China will affect the demand for assets, particularly in the US. This could push yields and increase overall borrowing cost. Investments by China over the years helped keep US yields at a lower level.

Excess saving in China, combined with those of other countries, kept borrowing costs low in the global economy in the period preceding the financial crisis. Now with the correction in what former Federal Reserve Chairman Ben Bernanke called the global savings glut, interest rates could go up.

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Although China's investment in US government bonds is falling, it still stands at over a trillion dollars. But China, instead of being a supplier of savings, will now start importing capital. According to estimates by Morgan Stanley, it will need net capital inflow in excess of $200 billion annually between 2019 and 2030. The overall shift could tighten financial conditions in global markets and could affect fund flows to other countries that run a current account deficit, such as India.

Second, China will need to open up its financial system. This will present both risks and opportunities. While it will help attract capital, this could also uncover vulnerabilities in the system. Relatively liberal movement of funds could lead to capital flight. As the economy is expected to slow down, Chinese investors who are not allowed to move capital freely may want to invest in other parts of the world to diversify their holdings.

Further, China has seen a significant build-up of leverage after the financial crisis. The risks in the financial sector could increase with higher capital mobility. It is being reported that default in the Chinese bond market is on the rise. This could lead to higher volatility in financial markets.

As China becomes a net importer of goods and services, the allegation that it uses means such as keeping its currency undervalued to promote exports would weaken. It carried more weight when China was running a large current account surplus. However, it may still not change US President Donald Trump’s position, as his target is the bilateral trade deficit. Things could get complicated as the US expects China to not allow its currency to depreciate. But with the current account slipping into deficit, China would not want to use its reserves to defend its currency all the time. This could again raise trade tensions and affect the global economy.

How will all this affect the Indian economy? The actual impact, of course, will depend on how smoothly the transition happens. A rise in risk aversion and financial market volatility will naturally affect the India economy negatively. At a broader level, the shift in China from investment to consumption is also an opportunity. As China becomes a net importer, there will be opportunities to take up the space vacated by it in the global market.

However, as highlighted earlier by this writer, India will need to implement structural reforms to benefit from the situation. It will also need to increase the rate of savings to reduce the dependence on foreign capital to fund growth.